The Latest From McDonald’s

December 16th, 2016 by Trefis Team

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McDonald's

While on the surface, third quarter earnings at McDonald’s may have seemed positive with comparables up in all the four regions, it is important to note that the quarter did not include the full impact of the performance after the launch of All Day Breakfast. Further, the revenues continued to fall even in the third quarter. To make matters worse, the company’s future guidance was at best uncertain, as it focused “not on quarter to quarter performance but long term sustained growth.” However, since then the company’s stock price has risen approximately 8%.

The Rise In McDonald’s Stock Price
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Although the main reason behind the rise in the stock price is the election of Donald Trump in the U.S., it would be unfair to say that McDonald’s is not trying hard to maintain its spot in the extremely competitive restaurant space. In this note, we discuss some of the latest initiatives taken by the company to promote continued growth.

Innovation In The Menu

McDonald’s tried to reinvent itself in Italy by launching a new version of a burger filled with Nutella. It is like a soft sweet roll, with a liberal helping of chocolate spread in the middle. The chain has also decided to launch a bigger and a smaller version of the very famous Big Mac. Although the original Big Mac will stay on the menu, we can expect to see new versions and innovations of it soon. It has already introduced a Sriracha hot sauce version of the Big Mac in Columbus, Ohio. Furthermore, the Sriracha sauce has been added as a dipping sauce for McNuggets and French fries. The innovation is crucial for the company, given the slowdown of All Day Breakfast it launched last year and based its turnaround on. However, the initial response of customers to its Nutella Burger has been mixed, with many raising issues relating to palm oil usage in McDonald’s products. Rating agency Fitch believes McDonald’s will continue to lose market share in the U.S. due to heightened competition due to the rise of specialty burger competitors and increasing breakfast competition. Making matters worse would be the decreased growth forecast of food away from home.

Refreshing The McCafes

McDonald’s is also looking at refreshing its McCafe concept next year, to keep pace with Starbucks and Dunkin’ Donuts. In 2015, McCafe was the top third specialty coffee shop by sales, recording $1.4 billion in sales from around 5,000 outlets, significantly lower than Starbucks (the top players) which generated nearly $21 billion in sales from more than 22,000 outlets. As per the new concept, McDonald’s will focus on seasonal beverages and increasing discounts. It is likely to introduce $1 drip coffee and a $2 specialty beverage deal for the first quarter of next year. The offering of coffee can complement the chain’s food offerings, and can play an important role in its strategy to meet customer requirements, while beating competition. However, McCafes are unlikely to attract coffee connoisseurs or those who are looking for a premium experience such as the one provided with Starbucks. We may see some addition in the average spend per customer, but an addition to the number of customers visiting the store is unlikely.

Digital Innovations

To cut through the waiting time and manage the through-put, McDonald’s plans to introduce table service and self-ordering kiosks across its 14,200 stores in the U.S. The concept has been pilot tested at 500 locations in New York, Florida, and Southern California. McDonald’s will also introduce a mobile payments platform to make the ordering process seamless. The company said that it expects the new upgrade to be completed in 2017, and provide a boost to average check size. The move is likely aimed towards the younger, more tech-savvy generations, such as millennials, who form the majority of the U.S. population. The fact that just 20% of millennials have tried the company’s flagship Big Mac is not encouraging. Other initiatives taken to cater to the millennials include healthier food options, fresh burgers, and customized orders.

A Look At Self Serving Kiosks At McDonald’s

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However, the digital initiatives may not sit well with older generations to whom McDonald’s has historically catered. Furthermore, the initiatives will require an additional investment of $28,000 and $56,000 per restaurant. It is quite possible that the benefits from more customers will be outweighed by the cost of hiring more employees to educate the customers about touch screens. It will also be difficult for the chain to convince its franchisee owners to foot the additional cost of investments.

Lower Raw Material Costs

The main raw material used in McDonald’s burgers is beef and pork (for patties). The recent slump in the price of beef and pork is likely to help the company offset the impact of higher wages. Cowen Group has forecast that ground beef prices could fall 10% to 15% between 2018 and 2020. The lower operating costs may boost McDonald’s margins. However, the recent decision to use fresh beef patties at its restaurants may cost the company more than the savings from cheap raw material. The move towards fresh patties will not only prove to be expensive, but also increase the wait time for customers, hampering the ability to serve large number of customers quickly. The competition between the major players in the quick service sector has intensified lately, as is visible in stagnant revenue growth. In such a scenario, it becomes imperative for McDonald’s to maintain its status as a value meal provider at a fast speed and economical prices.

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Increasing Wages

The fast food or food and beverage industry is notoriously famous for its long working hours and low pay. Most of the players in the market are now under the pump to raise the wages of their employees. The hike in wages could increase McDonald’s operating costs slightly. However, McDonald’s, which raised the salaries of its workers by $1 per hour in 2015, believes that a salary hike results in an improvement in customer satisfaction scores and lower attrition rates. Moreover, under the new Trump administration, corporations and employees are likely to see a lower tax burden due to the proposed decrease in corporate tax rates, and the proposed 13% cut in federal income tax for those making below $75,000 a year. This gives corporations more room to contribute towards improving labor conditions, while establishing themselves as a favorable workplace for employees.

Shift In EU Tax Base

McDonald’s announced that it will relocate its EU tax base to the U.K. from Luxembourg. The decision comes on the back of a formal investigation by the European Commission of Luxembourg’s 2009 tax deal with McDonald’s that allowed the burger giant to evade taxes. According to Financial Times, McDonald’s potentially faced an order from the bloc to pay back taxes of $500 million to Luxembourg. As per the new setup, McDonald’s will pay the U.K. tax on the royalties the company receives outside the U.S. Under U.K. rules, profits earned by overseas arms or a U.K. registered company are effectively exempt from U.K. tax even if the income is untaxed. Furthermore, taxes in Britain are relatively lower at 20%, and the government plans to cut it to 17% by 2020.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for McDonald’s

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